Importance of External Auditors

The auditors of Enron did fail in their task of providing a duty of care to all of the parties. The main reason for this is that they failed to correctly audit the assets and financial position of Enron resulting in all stakeholders having no clue about the forthcoming collapse of Enron. This resulted in the stakeholders facing a very critical condition or a phase where in they were not sure if they would be able to recover their investments and debts or not. The auditing process has revealed several issues and findings of problems within the accounting system and the same have been discussed as the primary areas of exposure, areas of possible mishandling of accounts

Arthur Andersen (AA) contributed to the Enron disaster when it has failed to the management by failing to have Enron establish and enforce its own internal control. There has been flaws to AA‘s internal control. There has been assumption that AA partners were too motivated by revenue recognition thus, overlooking several criteria when providing their services to Enron. Additionally, AA also recognised the retention of audit clients as vital and a loss of any clients would be disadvantaged to an auditor’s career. In AA internal control, the person who is able to make most of the decisions is the person who is most concerned about the revenue or losses of the client’s company.

Legitimacy in accounting practices is ensured by the check and balance of having independent auditors from registered public accountant firms reviewing financial practices. The report features eleven sections and these sections pertain to accounting overview, independence of auditors to reduce interest conflicts, corporate responsibility, financial disclosures, tax returns, criminal fraud and various elements of white collar criminal activity (107th Congress

This research paper analyzes the degree of an auditor's liability to clients and third parties under applicable law.

In October 2001, Enron Corporation which was one of the world major energy, commodities and service companies with claimed revenues of nearly 111 billion dollars during 2000 collapsed under the weight of massive fraud in that it has become largest bankruptcy recognition in the US economy. Enron’s earning report was extremely skewed that losses were not represented in their entirety, prompting more and more wishing to participate in what seemed like a profitable company. After collapse of Enron, Auditor independence has become a social issue that weather auditor has to be independent or not. In addition, while auditing must consider matters objectively with dispassion, there were still doubts whether it implemented well. Further, there has been much speculation about the need for the mandatory rotation of auditors or audit firm rotation to warn false accounting between audit firm and client. By examining Enron case, this essay will discuss about advantages and drawbacks of the mandatory rotation of

a. A third-party user cares whether the auditor is independent so that the user could evaluate the credibility of the financial statements and determine whether or not to rely on the financial statements to make investment or business decisions. In addition, through assessing the auditor’s independence, the stakeholders could also better evaluate the performance of the management and the value of the audit work.

Independence is considered to be one of the most discussed in accounting literature and is considered to be comprised of two parts (Humphrey, 2008). The first is organizational independence which refers to the auditors willingness to comply with professional standards (Guenin-Parcini, Malsh, Tremblay, 2015). The second aspect

Two of the most infamous audit firm failures exhibited similar characteristics. Audit firms Laventhol & Horwath (L&H) and Arthur Andersen (Andersen) were both conflicted with the audit clients. L&H performed financial practices for its client, PTL Club, in the form of check preparation from a secret payroll account. On the other hand, Andersen was subject to the self-review threat, when it performed significant and high-valued consulting engagements for its client, Enron, while at the same time, performed external audit for the same client (Demski 51). Both audit firms tolerated the clients’ questionable financial or accounting practices, despite the apparent and significant internal control lapses and fraud red flags. Furthermore, both audit firms were accused of applying sloppy and reckless audits that shrouded the problematic practices of the clients and lead to the oversight of inappropriate financial or accounting procedures. Both L&H and Andersen were associated with highly acclaimed clients with integrity issues and eventually lead to the audit firms’ downfall in the 1980s and 2000s, respectively.

In a free and open market, listed companies are required by law to provide their stakeholders with financial information that is credible. One method that can be used to obtain a trustworthy and objective financial reporting is through statutory auditing. However, the recent financial scandals and crisis have renewed concerns regarding the tenure of auditors and its impact on their audit quality and independence. Regulators and other experts have become concerned that the familiarity created between management and auditors over time and the need to retain client firms weakens the independence of auditors, and adversely affect the quality of their audit reports (Arel 2013: 16). On the other hand, those opposing mandatory audit firm rotation claim that the costs incurred as a result of frequently changing auditing firms surpasse its benefits by far (Beasley et al., 2009:67). Pozen (2012:11) points out that the chances of audit failures are greater during the early stages of an auditor-client relationship since the new auditor may not have auditor knowledge regarding operations, processes, and client-specific risks. The role of audit firm rotation as a means of sustaining the independence and reliability of financial reporting will be discussed in the paper as well as the views of stakeholders regarding the rotation rule and make recommendations on how to improve audit quality and independence will be considered.

Some examples of a loss of independence would be if an auditor was on an audit team in which they owned stock in, if a family member was working for the client, interactions between an auditor and client including families outside of businesses, and even an auditor dating an employee of a client. A real example would be in January 2014, KPMG provided non-audit relating services to affiliates of an audit client during an actual audit, in addition some KPMG personal owned stock of the audit client (US Securities and Exchange Commission, 2014).

Independence is a fundamental to the reliability of auditors’ reports. It is an attitude of mind characterized by integrity and an objective approach to professional works. A professional auditor should work both independent and seen to be so. Nowadays, but, the trend of providing non-audit services to audit clients seem to be sweeping accounting firms all over the world; impacts of independence impairment caused by this trend should not be ignored.

Auditors provide comfort and assurance regarding a corporation’s financial position and its financial statements. The assurance field centers upon one common trait: trust. Trust is vital to an auditor because investors must feel confident that the financial statements accurately reflect the company’s financial standing. Auditor independence is the backbone behind the perceived trust and comfort an auditor provides while examining the financial statements. If an auditor impairs independence, how can an investor ensure that he or she is relying upon accurate information? Since trust is an essential part of the auditor-investor relationship, the government and accounting oversight boards have taken several measures

Also based Andersen (cited in Beattie, Fearnley 2015), the Independent Oversight Board (IOB) set up by Andersen in the US, after the Enron problems emerged but before the firm collapsed, recommended that some consulting services provided by the firm should be separated into partnerships managed independently from audit partners and without financial interdependence.

Internal auditors cannot effectively provide an analysis on the company’s internal dealings as they are part of the company. External auditors, however, can observe these processes from the outside and then determine where the funds of the company and whether the dealings adhere to the regulations. Using external auditors in a company prevents conflict of interest from happening. Conflict of interest is a situation where an individual or organization has multiple interests and of those multiple interests, one could possible corrupt the motivation for an act on the other when the auditor has any kind of beneficial interest in their client’s performance. In other circumstances, there is also the threat of familiarity where auditors become

Since reliable financial information is essential for investors and other stakeholders to take adequate decisions, this reliability must be backed by independent review performed by independent and certified auditing firms, which are supposed to verify and certify financial statements issued by a company’s management. If the auditor is not competent and independent from management, the audit of the financial statements loses its credibility (Schelker, 2013, p.295). According to Impastato (2003), because of audit failures, accountants are to blame for investors losing billions of dollars in earnings in addition to market capitalization (as cited in Grubbs & Ethridge 2007).